January 14, 2016
Authored by: Jerry Blanchard
(Note: Part 1 is available here.)
One of the problem areas that came up during the recession was the accounting treatment for loan participations and loan sales. The difficulty arose from the fact that FASB changed the guidance for how to recognize a “true sale” several times over the last decade and not all banks realized that their form documents needed to be changed to reflect those changes. The current guidance is now found in Accounting Standards Codification Topic 860 “Transfer and Servicing” (formerly FAS 166 “Accounting for Transfers of Financial Assets”) which itself was an update of FAS 140 “Accounting Transfers and Servicing of Financial Assets and Extinguishments of Liabilities.
If we go back ten years ago when I had written the cisa exam, there were several different variations on how loan participations divided distributions from loan payments among the parties. Pro rata is perhaps the most common but it was also typical to see both LIFO (last in first out) and FIFO (first in first out) arrangements. The older accounting treatment allowed an institution using any these different distribution models to be treat the transaction as a true sale, thus removing the asset from its books. The accounting treatment today is dramatically different. Under ASC 860, neither LIFO nor FIFO participations transferred on or after the beginning of a bank’s first annual reporting period that began after November 15, 2009 qualify for sale accounting and must instead be reported as secured borrowings.
Many banks actually used preprinted loan participation forms where one simply checks the block showing whether distributions were shared pro rata, LIFO, or FIFO and continued to use such forms after the FAS change. This resulted in interesting situations where pieces of the same loans can receive differing accounting treatments. For example, assume that Bank A originated a $1 million loan on June 1, 2009 and sold 50% of it on a LIFO basis to Bank B on the same date. Assuming that it meets all of the tests necessary to move an asset off of its books then Bank A can treat that as a true sale. If Bank A later sells another 10% of the loan to Bank C on March 1, 2010, also on a LIFO basis, that transfer will not be treated as a true sale and must be accounted as a secured loan by Bank C to Bank A.